Friday, November 23, 2012

Let Them Eat Cat Food?

The British government is considering a new type of pension scheme to address the rapid disappearance of final salary pension schemes and encourage more people to save for their retirement.

Pensions minister Steve Webb said on Thursday he wants to bridge the gap between the two traditional forms of pensions - defined benefit (DB), which promises employees a pension based on their salaries, and defined contribution (DC), which offers no guarantee about how much the pension will finally pay out.

DB has become too costly for most employers, which are struggling to plug deficits and spiralling pension fund liabilities, while DC schemes have been criticised for putting too much investment risk on the individual members.

Known as "defined ambition," the scheme will encourage fewer and larger pension plans, and will share risks equally between employers and employees, Webb said in a paper called "Reinvigorating workplace pensions."

The scheme will offer workers some guarantees from their employers on the size of their pension pot and the rough size of their retirement pay packet.

The government is concerned Britain's ageing population needs to do more to provide for itself in later life. The number of active members of occupational schemes has declined from a peak of 12.2 million in 1967, to 8.2 million in 2011.

"For nearly half a century, we have seen declining numbers of people in workplace schemes - I am determined to reverse this trend and ensure we have pensions that are affordable to employers and attractive to employees," Webb said.

His concern is shared in Europe. The EU's pensions and insurance watchdog wants to set Europe-wide standards for national old-age pension schemes in a bid to boost investment in private pensions.

The government has called for the creation of a third type of pension to bridge the gap between defined benefit and defined contribution schemes.

In a paper titled, Reinvigorating Workplace Pensions, the Department for Work and Pensions outlines proposals for what it calls a “defined ambition” pension plan which aims to share risk between employer and employee.

According to the proposals, DA schemes could offer greater certainty of the final value of one’s pension pot than in DC schemes while not costing as much as DB schemes.

Two methods of implementing this suggested by the DWP include conversion of benefits, where the employer promises a certain level of benefits which are converted to cash if the employee leaves the company; and moneyback guarantees where a saver is guaranteed to get back at least the amount they put in.

Joanne Segars, chief executive of the National Association of Pension Funds, said: “Pensions are now very polarised, particularly in the private sector, with older final salary pensions at one end, and the newer defined contribution system at the other.

“Either the business bears the risk of paying a final salary deal, or the saver carries the risk of not knowing exactly how much they will get.

“There could be a middle way where that risk is shared.”

Peter McDonald, chief actuary at PricewaterhouseCoopers, believes the proposals hold a lot of merit, but the sticking point will be whether companies have the appetite to provide these types of pensions.He warned that “constant tinkering” with the pension rules has left employers disillusioned and there is little appetite to take on any more risk than they need to.

Mr McDonald said: “The proposal to create a middle ground between defined benefit and defined contribution pensions is a great idea if it can work. The challenge will be persuading employers to move back towards an arrangement where they are tied into a pension promise, as so many have swung away from offering DB schemes.

“The idea of limiting employer’s DB promises to only when the worker is still at the company, could lead to unintended consequences. For example, workers are likely to think twice before leaving a job that offers a DB scheme and this could create an unwelcome staff backlog for many companies.”

Jim Bligh, head of labour market and pensions policy at the Confederation of British Industry, said: “Getting people to save more is essential for a comfortable retirement and the long-term sustainability of our economy, so the government’s efforts are welcome.

“As the pattern of people’s working lives change, new forms of savings for retirement are necessary. Automatic enrolment is a key part of this, but is not enough on its own. Encouraging new approaches to saving above the statutory level is a goal that businesses, government and the financial services sector need to work together on.”

The UK pensions crisis continues with millions at risk of poverty in old age as savings hit a record low. Moreover, they have reached an annuity tipping point where the slump in annuity rates in recent years is so severe that pension savers looking at annuity rates on offer today could conclude that saving into a pension is not just poor value but is in fact a waste of money.

To give the impression that they're doing something resembling work, public relations and marketing types like to indulge in something they refer to as "brainstorming".

This involves sitting around a table putting forward progressively sillier ideas until they arrive at the daftest one they can find before unleashing it on an unsuspecting public.

It seems as if staff at the Department for Work & Pensions have had the brainstorming session to end all brainstorming sessions and it's resulted in something called the "Defined Ambition" pension.

Today's workplace pensions are split between defined benefit (final salary) and defined contribution (money purchase). The former guarantees you a percentage of final salary when you sail off into the sunset. What you get with the latter depends on investment returns. Most of the public sector are on the first type, although ministers would like to change that for everyone other than MPs and top civil servants. Most of the private sector are on the second, or they soon will be. If they've even signed up.

A signature won't be necessary for long under Government plans to automatically enroll people in workplace schemes. But even then the DWP realises that the amount it's telling employees to stash away might be insufficient if it wants to get the state off the hook for retirement provision.

So it would like people to save more, and after a really intense brainstorming session the DWP has decided that it could do this by persuading employers to risk signing up to a sort of "halfway house" pension that offers employees guarantees. Just guarantees that aren't as onerous as traditional final salary schemes, which can break companies that offer them.

A number of options are explored for its inadequately Defined Ambition, but the DWP doesn't address the nub of the problem: Offering guaranteed returns is ruinously expensive.It is because of this that the DWP's defined ambitions are going to be thwarted. Some employers might have made encouraging noises but they'll run a mile after their finance directors work out the price.

What could make workplace pensions better is to cut down on costs, perhaps by pooling lots of employers' defined contribution schemes. But the DWP is rather light on ways of achieving this.

And anyway, there are strong arguments to suggest that saving through a pension is exactly what a lot of people shouldn't be doing at the moment.With interest rates low, it makes sense for those who have mortgages to use their spare cash to pay down the capital and to attack their other debts. If they do they'll have ample funds free to save when interest rates and investment returns may both have risen.

As for the DA pension? It sounds very much like a way of trying to sugar coat (or avoid) an unpalatable fact. Sort of like calling radiation "magic moonbeams".

The best way, the only way, of ensuring people have better pensions and are thus less reliant on the state is to tell them the truth: They can chose to work for longer or they can save more. It really is that simple. Trying to sweeten the pill with silliness like a new sort of pension added to an already horribly complicated mix won't change that.

I agree with Mr. Moore's assessment of the DA scheme but disagree with his proposal. The best way of ensuring better pensions is for the UK to create large, well-governed defined-benefit plans managing pensions for all its citizens. This new "defined ambition" (DA) sounds like Canada's PRPP solution, ie., another pipe dream that will exacerbate pension poverty while it enriches banks, insurance companies and mutual funds.

As UK insurers take the lead in carving out the pension turkey, I'm increasingly concerned that the world is going over the pension cliff. These private sector solutions will turn out to be much more expensive and worse still, they will leave far too many retirees scrambling to get by during their golden years.

Pity that the Brits are wasting so much time and money to come up with such pathetic proposals. When it comes to pensions, the new mantra of the day is "let them eat cat food!".

Below, with people living longer, but not thinking about how they'll pay for it, Britain's decided to dip into workers' wages and force them to save, even if they're barely out of school. RT's Sara Firth reports on why the seemingly-good intentions could leave people out of pocket.

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I am an independent senior economist and pension and investment analyst with years of experience working on the buy and sell-side. I have researched and invested in traditional and alternative asset classes at two of the largest public pension funds in Canada, the Caisse de dépôt et placement du Québec (Caisse) and the Public Sector Pension Investment Board (PSP Investments). I've also consulted the Treasury Board Secretariat of Canada on the governance of the Federal Public Service Pension Plan (2007) and been invited to speak at the Standing Committee on Finance (2009) and the Senate Standing Committee on Banking, Commerce and Trade (2010) to discuss Canada's pension system. You can follow my blog posts on your Bloomberg terminal and track me on Twitter (@PensionPulse) where I post many links to pension and investment articles as well as my market thoughts and other articles of interest.

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